The guidance, contained in a supervisory letter sent to Federal Reserve bank examiners and supervisors as well as banking organizations supervised by the Federal Reserve, codifies and supplements existing supervisory practices.

"While equity investments in non-financial companies can contribute substantially to earnings, such investments, like other rapidly growing and highly profitable business lines, can entail significant market, liquidity and other risks," wrote Richard Spillenkothen, director of the Board's Division of Banking Supervision and Regulation.

"Sound investment and risk management practices and strong capital positions are critical elements in the prudent conduct of these activities," he wrote.

The guidance advises supervisors to encourage banking institutions to make appropriate public disclosures relevant to their equity investments, including accounting techniques and valuation methods used, realized and unrealized gains and losses, and insights regarding the potential performance of investments under alternative market conditions.

Merchant banking and equity investment have emerged as an increasingly important source of earnings at some institutions and the Gramm-Leach-Bliley Act enacted in November provides additional merchant banking authority for financial holding companies.

Supervisory letters are the Federal Reserve's primary means of communicating key policy directives to its examiners, supervisory staff and the banking industry.
Supervisory letters can be viewed on the Board's web site at www.federalreserve.gov/boarddocs/srletters.